In economics, the Dutch disease is the apparent relationship between the increase in the economic
development of natural resources and a decline in the manufacturing sector. The mechanism
is that an increase in revenues from natural resources will make a given nation's currency
stronger compared to that of other nations, resulting in the nation's other exports becoming
more expensive for other countries to buy, and imports becoming cheaper, making the manufacturing
sector less competitive. While it most often refers to natural resource discovery, it can
also refer to "any development that results in a large inflow of foreign currency, including
a sharp surge in natural resource prices, foreign assistance, and foreign direct investment".
The term was coined in 1977 by The Economist to describe the decline of the manufacturing
sector in the Netherlands after the discovery of a large natural gas field in 1959.
Model The classic economic model describing Dutch
Disease was developed by the economists W. Max Corden and J. Peter Neary in 1982. In
the model, there is a non-tradable sector and two tradable sectors: the booming sector,
and the lagging tradable sector. The booming sector is usually the extraction of natural
resources such as oil, natural gas, gold, copper, diamonds or bauxite, or the production
of crops, such as coffee or cocoa. The lagging sector is usually manufacturing or agriculture.
A resource boom affects this economy in two ways. In the "resource movement effect", the
resource boom increases demand for labor, which causes production to shift toward the
booming sector, away from the lagging sector. This shift in labor from the lagging sector
to the booming sector is called direct-deindustrialization. However, this effect can be negligible, since
the hydrocarbon and mineral sectors tend to employ few people. The "spending effect" occurs
as a result of the extra revenue brought in by the resource boom. It increases demand
for labor in the non-tradable sector, at the expense of the lagging sector. This shift
from the lagging sector to the non-tradable sector is called indirect-deindustrialization.
The increased demand for non-traded goods increases their price. However, prices in
the traded good sector are set internationally, so they cannot change. This amounts to an
increase in the real exchange rate. Resource-based international trade
In a model of international trade based on resource endowments as the Heckscher–Ohlin/Heckscher–Ohlin-Vanek,
the Dutch disease can be explained by the Rybczynski theorem.
Effects Simple trade models suggest that a country
should specialize in industries in which it has a comparative advantage; so a country
rich in some natural resources would be better off specializing in the extraction of those
natural resources. However, other theories suggest that this is detrimental, for example
when the natural resources deplete or prices decrease and competitive manufacturing cannot
return as quickly as it left. This is because technological growth is smaller in the booming
sector and the non-tradable sector than the non-booming tradable sector. Because that
economy had smaller technological growth than did other countries, its comparative advantage
in non-booming tradable goods will have shrunk, thus leading firms not to invest in the tradables
sector. Also, volatility in the price of natural resources, and thus the real exchange rate,
limits investment by private firms, because firms will not invest if they are not sure
what the future economic conditions will be. Minimization
There are two basic ways to reduce the threat of Dutch disease: by slowing the appreciation
of the real exchange rate and by boosting the competitiveness of the manufacturing sector.
One approach is to sterilize the boom revenues, that is, not to bring all the revenues into
the country all at once, and to save some of the revenues abroad in special funds and
bring them in slowly. In developing countries, this can be politically difficult as there
is often pressure to spend the boom revenues immediately to alleviate poverty, but this
ignores broader macroeconomic implications. Sterilisation will reduce the spending effect,
alleviating some of the effects of inflation. Another benefit of letting the revenues into
the country slowly is that it can give a country a stable revenue stream, giving more certainty
to revenues from year to year. Also, by saving the boom revenues, a country is saving some
of the revenues for future generations. Examples of these sovereign wealth funds include the
Australian Government Future Fund, the Government Pension Fund in Norway, the Stabilization
Fund of the Russian Federation, the State Oil Fund of Azerbaijan, Alberta Heritage Savings
Trust Fund of Alberta, Canada, and the Future Generations Fund of the State of Kuwait established
in 1976. Recent talks led by the United Nations Development Programme in Cambodia – International
Oil and Gas Conference on fueling poverty reduction – point out the need for better
education of state officials and energy cadres linked to a possible Sudden Wealth Fund to
avoid the Resource curse. Another strategy for avoiding real exchange
rate appreciation is to increase saving in the economy in order to reduce large capital
inflows which may appreciate the real exchange rate. This can be done if the country runs
a budget surplus. A country can encourage individuals and firms to save more by reducing
income and profit taxes. By increasing saving, a country can reduce the need for loans to
finance government deficits and foreign direct investment.
Investments in education and infrastructure can increase the competitiveness of the lagging
manufacturing or agriculture sector. Another approach is government protectionism of the
lagging sector, that is, increase in subsidies or tariffs. However, this could worsen the
effects of Dutch Disease, as large inflows of foreign capital are usually provided by
the export sector and bought up by the import sector. Imposing tariffs on imported goods
will artificially reduce that sector's demand for foreign currency, leading to further appreciation
of the real exchange rate. Diagnosis
It is usually difficult to be certain that a country has Dutch Disease because it is
difficult to prove the relationship between an increase in natural resource revenues,
the real-exchange rate, and a decline in the lagging sector. An appreciation in the real
exchange rate could be caused by other things such as productivity increases in the Balassa-Samuelson
effect, changes in the terms of trade and large capital inflows. Often these capital
inflows are caused by foreign direct investment or to finance a country's debt.
Similarly, it is difficult to show what is causing a decrease in the lagging sector.
A case in point is the Netherlands. Though this effect is named after the Netherlands,
economists have argued that the decline in Dutch manufacturing was actually caused by
unsustainable spending on social services. Examples
Australian gold rush in the 19th century, first documented by Cairns in 1859
Australian mineral commodities in the 2000s and 2010s
Signs of emerging Dutch disease in Chile in the late 2000s, due to the boom in mineral
commodity prices Azerbaijani oil in the 2000s
Canada's rising dollar hampered its manufacturing sector beginning in the 2000s and continues
today due to foreign demand for natural resources, with the Athabasca oil sands becoming increasingly
dominant. Indonesia's greatly increased export revenues
after the oil booms in 1974 and 1979 Nigeria and other post-colonial African states
in the 1990s The Philippines' strong foreign exchange market
inflows in the 2000s leading to appreciation of currency and loss of competitiveness
Russian oil and natural gas in the 2000s Gold and other wealth imported to Spain during
the 16th century from the Americas The effect of North Sea Oil on manufacturing
sectors in Norway and the UK in 1970-1990. Post-disaster booms accompanied by inflation
following the provision of large amounts of relief and recovery assistance such as occurred
in some places in Asia following the Asian tsunami in 2004
Using the official exchange rate, Caracas is the most expensive city in the world, though
the black market exchange rate is said to be as much as fourteen times as many bolivares
to the dollar as the official one. Being a large exporter of oil revenues also keeps
the currency's value above what it would otherwise be.
Using data on 118 countries over the period 1970–2007, a study by economists at the
University of Cambridge provides evidence that the Dutch disease does not operate in
primary commodity-abundant countries. They also show that it is the volatility in commodity
prices, rather than abundance per se, that drives the resource curse paradox.
See also Resource curse
Norwegian paradox References
Further reading Buiter, Willem H.; Purvis, Douglas D.. "Oil,
Disinflation, and Export Competitiveness: A Model of the 'Dutch Disease'". In Bhandari,
Jagdeep S.; Putnam, Bluford H. Economic Interdependence and Flexible Exchange Rates. Cambridge: MIT
Press. pp. 221–247. ISBN 0-262-02177-3. External links
Norway's Government Pension Fund State Oil Fund of the Azerbaijan Republic